Buying a home is a standard part of the American Dream — but what does it really take to achieve that dream? And how do you know when you’re ready?
These questions are especially pressing for first-time homebuyers who have never been through the mortgage qualification checklist before.
Of course, the entire home buying process can feel even more overwhelming in a volatile housing market, which is why it’s always a good idea to talk to highly-experienced mortgage lenders in Detroit Michigan before you begin your search.
It doesn’t cost you anything to talk to an expert, and your local mortgage loan officer will know everything about the current housing market in your area, including up-to-date information about any special programs you may qualify for that will make buying a home more affordable.
Still, it’s good to be armed with some foundational knowledge before you dip your toes into the mortgage lending waters, so below we’ll discuss mortgage basics such as lending lingo, what you need for your down payment, and more.
What is a Mortgage Used for?
A mortgage is typically used to purchase a house — it is simply a loan that a buyer takes out for a house, land, or any other real estate.
Most homeowners rely on a mortgage to purchase their first home, with 64.8% of U.S. homeowners currently holding mortgages on their homes.
The cool thing about mortgages, and what makes them different from other types of loans, is that they are backed by an appreciating asset. In other words, unlike car loans, which are secured by an asset that goes down in value, or student loans, personal loans, and credit card debt, which are unsecured, mortgage loans use an asset that goes up in value as collateral.
This makes mortgages some of the most secure loans and enables lenders to offer longer terms and lower interest rates than borrowers can get on other types of loans, bringing the dream of homeownership within reach for more Americans.
In addition, since homeownership rates are considered a bedrock of a nation’s financial health, the government offers even more mortgage programs and incentives, such as allowing homeowners to deduct their mortgage interest on their taxes.
All-in-all, taking the leap into homeownership is one of the best things you can do for yourself and your family’s financial future — if you’re ready for it. More on this below.
How Many Years of Salary Do You Need to Buy a House?
There’s no set rule for how many years of salary you need to show in order to qualify for a mortgage — the answer really depends on how big the loan is, how much you have saved for a down payment, what your interest rate is, what loan programs you qualify for, and a dozen other factors.
The best way to know if you’re financially ready to buy a house is to use a free online mortgage calculator, which you can tailor to your own specific situation, including your down payment amount and your interest rate.
However, there are a few clear rules of thumb that can help you determine how much house you can afford, even before you begin your search for a mortgage lender in Michigan.
1. Proof of Income.
When you apply for mortgage preapproval, your mortgage lender will want to see proof of income. Usually, this means that you need to show at least 2 months of paystubs to verify your income and your last one or two tax returns to establish your AGI (Adjusted Gross Income).
That doesn’t mean that you have to have kept the same job for the last two years, or even the last year. Particularly in today’s mobile, gig economy, lenders understand borrowers make more frequent career moves than they did even a decade ago.
You just need to be able to show a couple years of steady earnings, whether you do that through W2s, paystubs, 1099s, or self-employment income on IRS Schedule C.
2. Debt-to-Income Ratio
Perhaps even more important than establishing your overall income is knowing and understanding your Debt-to-Income Ratio (DTI).
We could easily write an entire article on what DTI is and why it’s important, but in the most basic terms, your DTI is a comparison between the amount of money you owe in debt to the amount of money you earn.
So, for example, if you earn $5000 in pre-tax income and you have $1000 per month in debt payments (car loans, student loans, credit cards, etc.) then your DTI is $1000/$5000 or 20%.
This is important because certain government-backed loan programs have maximum DTI requirements in order to qualify.
For instance, if you want to get approved for an FHA loan, the current requirements are that your housing debt, including all mortgage insurance and homeowners taxes, is only 31% of your gross income and that your total DTI is 43% or less.
Similarly, the Fannie Mae and Freddie Mac loan programs have maximum DTI caps of 36% (although both programs will go up to 45% if certain other requirements are met).
Other than saving for a down payment, one of the best things you can do to set yourself up for the home buying process is pay down other debt. Even eliminating payments on one or two credit cards can dramatically impact your DTI. If paying down debt isn’t possible at the moment, consider a debt consolidation program that will lower your monthly payment, thereby lowering your DTI.
As always, the best way to plan ahead for a home purchase is to talk with an expert local loan officer who can help you figure out how to qualify for a mortgage and walk you through how much house you can comfortably afford.
How Much Money Do You Need to Put Down on a House?
When most people think about the requirements for getting a mortgage loan, they’re really concerned about two issues: 1.) What is the minimum credit score that I need? and 2.) How much do I need to save for my down payment?
Again, the answer to both questions is: It depends.
There are many programs available to first-time homeowners and other buyers that can make the down payment requirement as little as 3%. There are even zero down payment programs that you could qualify for.
If we lived in an ideal world, every homebuyer would come to the closing table with a 20% down payment. But, as we all know, we do not live in an ideal world, and what makes sense for one person’s finances may not make sense for yours. Here are a few considerations:
Benefits of Putting at Least 20% Down
- Lower Monthly Payments. The larger your down payment, the lower your monthly payments will be. This could also help you qualify for a larger home since your housing DTI will be lower.
- More Equity in Your Home. When you put down a larger down payment, you have more equity in your home right off the bat, increasing your net worth and your financial stability.
- Better Mortgage Rates. A lower down payment makes you a bigger risk in the eyes of the lender and the government, resulting in higher interest rates.
- No Private Mortgage Insurance (PMI). For government-backed loans, which make up nearly all mortgage loans, the lender’s risk with a lower down payment is balanced out by the government’s promise to pay a portion of the loans should the borrower default. In order to guarantee the loans, the government requires the borrower to pay for private mortgage insurance. If you put at least 20% down, you won’t have to pay for PMI, reducing your monthly payment and helping you qualify for a more expensive home. (If you don’t have 20% down, be sure to contact your lender as soon as you have at least 20% equity in your home to drop PMI!)
Drawbacks of a Larger Down Payment
- Longer Time Frame to Buy a Home. If you find a great deal on the perfect home for your family, it may make sense to buy it now with a lower down payment.
- Depleting Your Savings or Investment Accounts. Although, generally speaking, there are few downsides to putting down as much as possible on your new home, it’s never wise to completely drain your savings or investments just to put down a larger down payment. You’ll need money for unexpected expenses once you buy a home, and you don’t ever want to leave yourself at zero just to get into a house. Opt for a lower down payment or a less expensive home.
Whatever you do, if you feel ready to take the next step toward homeownership, don’t let debt, messy finances, spotty job history, lower credit scores, or lack of a down payment stand in your way.